Arrowhead Capital Finance Ltd v KPMG LLP

This is an application by the defendant accountants (“KPMG”) to strike out the claim under CPR 3.4(2)(a) on the ground that the claimant's statement of case discloses no reasonable grounds for bringing the claim, alternatively for summary judgment pursuant to CPR 24.2. There are two issues. The first is whether KPMG owed a duty of care to the claimant (“Arrowhead”), who was not its client but an investment fund which loaned money to a special purpose vehicle which in turn loaned money to KPMG’s client, in performing the services for which it was engaged. The second is whether the claim is time barred on the ground that the damage which is an essential ingredient of a cause of action in tort occurred more than six years before 30 August 2011, the date when the claim form was issued.

Although the application is made on two bases, strike out under CPR 3.4(2)(a) and summary judgment under CPR 24.2, it is unnecessary to consider these separately. In both cases an applicant faces a high hurdle, but the parties were content to proceed on the basis of the test applicable for a summary judgment, that test not being in dispute. It is therefore necessary for KPMG to establish that the claim has no realistic prospect of success. In considering whether KPMG is able to do so, I apply the principles summarised by Lewison J in Easyair Ltd v. Opal Telecom Ltd [2009] EWHC 339 (Ch) at [15] which have been approved in later cases.

KPMG’s client was Dragon Futures Ltd (“Dragon”), an English company. Dragon carried out only minimal activities until 2003 when it decided that it would trade in the grey market in mobile telephones, a grey market being a trade in branded goods outside of the distribution channels authorised by the brand owners. In a typical transaction, Dragon would buy a consignment of mobile telephones from one party and sell them to another party for a profit. Dragon would therefore pay VAT on the purchase price, which it would reclaim from HM Customs & Excise (“HMCE”). It was critical to Dragon's business plan that Dragon would be able to recover VAT in this way.

In order to be recoverable the VAT in question had to qualify as "input tax" within the meaning of section 24(1) of the Value Added Tax Act 1994 which provides:

“Subject to the following provisions of this section, ‘input tax’, in relation to a taxable person, means the following tax, that is to say–

(a)

VAT on the supply to him of any goods or services;

(b)

VAT on the acquisition by him from another member State of any goods; and

(c)

VAT paid or payable by him on the importation of any goods from a place outside the member States,

being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him.”

If the purchases and sales, judged objectively, were devoid of economic substance, they would not be part of any economic activity, and the purchases would not qualify as supplies used or to be used for the purpose of a business. This was the position at all material times, although the point came into even sharper focus after a series of decisions by the European Court of Justice in 2006 holding that a transaction would not be vitiated by fraud elsewhere in the supply chain, provided that the trader seeking repayment of VAT had neither knowledge nor any means of knowledge of the fraud: see eg Optigen Ltd v. Customs & Excise Commissioners (Joined Cases C-354/03, C-355/03 and C-484/03) [2006] Ch 218. This was affirmed in Kittel v. Belgium (Joined Cases C-439/04 and 440/04) where the Court held at [61]:

“... where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct.”

At first Dragon traded on a fairly small scale in order to establish a track record and to test the market, but it was ambitious to expand its trading, for which purpose it would need to attract finance from investors. It recognised, however, that such investors would need to be satisfied about the viability of its business plan, including in particular the recoverability of VAT. In 2003 HMCE had introduced a package of measures to assist in combating fraud in the wholesale market in (among other things) mobile telephones. It is unnecessary for present purposes to describe what were known as "Carousel Frauds" or “Missing Trader Intra-Community Frauds”, but such schemes, designed to obtain a substantial repayment of sums which had never been paid as output tax, were widespread. In August 2003 Customs Notice 726 was published, in which HMCE set out advice to traders as to how they could avoid being caught up in such frauds and the checks which HMCE would expect them to take in order to demonstrate that they had done everything they could to ensure the integrity of the supply chain. If HMCE considered that the transactions for which VAT was sought to be recovered were not genuine transactions because they were part of such a fraud, a claim for recovery of VAT would be denied unless the trader concerned was able to satisfy HMCE that it had made appropriate checks.

Thus although the decisions in Optigen and Kittel provided authoritative rulings, they did not (at least so far as the present case is concerned) bring about any fundamental difference in what a trader was required to do or the circumstances in which VAT repayments could be successfully claimed. Mr. Philip Coppel QC made clear on behalf of Arrowhead that its case is that KPMG’s conduct fell short of the standards required as they already existed when the work was done in 2003 and 2004 and not merely short of any more demanding standards which may or may not have existed after 2006 as a result of the European Court decisions.

In order to ensure that it would be able to recover VAT, Dragon determined to establish rigorous operating procedures, which would go even further than the reasonable steps set out in Customs Notice 726. It took legal advice and in addition decided to engage the services of KPMG. It appears that initial contact with KPMG was made in early September 2003, and included a meeting on 16 September 2003 with Mr. Steve Simmonite, a director of KPMG and an expert in VAT, who had previously been with HMCE for 18 years, leaving in 1994 as a Senior Executive Officer. Mr. Jim Robinson, a director of Caydal LLC (“Caydal”), also attended that meeting. Caydal was a United States venture capital company which was itself an investor in Dragon and also a possible source of introductions to other potential investors.

The terms on which Dragon engaged KPMG were set out in KPMG’s engagement letter dated 17 September 2003. This provided that:

“We will deliver services to you in connection with the implementation of a due diligence strategy to address the threat posed by HM Customs & Excise (‘HMCE’) and its approach to companies dealing in the mobile telephone industry.

Scope of services

KPMG will provide the following services:

•

Review the existing business records to identify areas for attention.

•

Analyse the current measures Dragon Futures takes to protect itself from fraudulent traders.

•

Update the existing procedures to take into account the recent Budget measures.

•

Provide a regular review of systems and documentation, dates to be agreed with yourself.

We will agree with you, in advance, the scope of any further work that you require us to do over and above that detailed.”

The letter went on to identify the KPMG staff and resources responsible for undertaking this work and the charges which would apply, and stated that the engagement was accepted on the basis that KPMG's attached General Terms of Business would apply. It requested Dragon to read these terms carefully and pointed out that they included various exclusions and limitations on KPMG's liability. In particular, the letter drew specific attention to an exclusion of liability for indirect or consequential economic losses, to a limitation of liability in connection with direct losses, and to the fact that any claim against KPMG was required to be brought within four years of the work giving rise to the claim being performed. Although not specifically referred to in the engagement letter itself, the terms also provide that the contract between Dragon and KPMG would not create or give rise to any third party rights and excluded the application of any legislation giving to or conferring on third parties any contractual or other rights.

With a view to attracting potential investors, Dragon prepared two documents. The first, entitled “Dragon Financing Opportunity”, stated under the heading "Institutional Quality":

The second document, entitled “Dragon Business Plan”, included reference to "KPMG audits" under the heading "IQ Standards." It also referred to the management of the risk of being involved in a carousel fraud by means of (among other things) "KPMG Advice" and referred to KPMG as a "Resource" in being able to confirm to HMCE that proper diligence had been exercised as to the counterparties with which Dragon would deal.

Initial trading on a small scale took place from the beginning of October 2003 and continued until December. VAT returns were submitted and Dragon was initially successful in obtaining recovery of the VAT paid on its purchases.

As Christmas 2003 approached Dragon suspended its trading temporarily in order to concentrate on its negotiations to raise finance with which to expand its trading operations. On 9 December 2003 Mr. Robinson of Caydal e-mailed Mr. Simmonite, saying that Dragon had been successful in its initial trading and that he was “working with Dragon on financing options to allow for continued growth”. He explained that one option was loan finance and asked for “some guidance about the issues regarding using VAT returns receivables as an asset for the purposes of lending and also if you know any banks who may be more comfortable with this activity than any others”. Mr. Simmonite’s reply on the same day was as follows:

“Given the high risk nature of the business, joint and several liability issues, bondhouse etc it would be unusual for a bank would treat VAT repayments as an asset for the purpose of lending, especially as any repayments made to mobile phone dealers are generally on a without prejudice basis.

Although Customs have repaid Dragon's most recent VAT return without a verification visit this is unusual in this type of business and substantial delays in repayments are common place, whilst Customs make enquiries up and down the supply chain. As Dragon's trading volume increases I would expect to see Customs verifying returns before repayment is made, which will of course slow down the whole repayment process.

With regard to banks which are comfortable dealing with mobile phone dealers, I think the general rule is they are not very comfortable. It is often a question of how good a relationship the trader has with their bank manager and how long they have been a customer of the bank."

“Bondhouse” was a reference to one of the cases concerning carousel fraud which had been referred to the European Court of Justice.

During January 2004 Dragon succeeded in negotiating a loan facility with Arrowhead, which appears to have been introduced to Dragon through Caydal. As part of these negotiations, Dragon provided to Arrowhead the "Dragon Financing Opportunity" and "Dragon Business Plan” documents together with documents showing what due diligence it conducted on its trading counterparties, and referring to the fact that KPMG also conducted an independent due diligence exercise. There was, however, no direct contact between Arrowhead and KPMG.

The structure adopted for the provision of this finance was complex. Rather than Arrowhead lending to Dragon directly, it would make a loan to a Delaware company called Metro II LLC (“Metro”) which was a 100% subsidiary of a company associated with Arrowhead. This loan was secured by a senior secured promissory note issued by Metro. Metro would then make a loan to a Dubai Free Zone company called Dragon FZ LLC (“Dragon FZ"), a company with the same directors as Dragon, which was secured by a senior secured promissory note issued by Dragon FZ. Dragon FZ (which was also to act as Dragon's undisclosed principal pursuant to a Commissionaire Agreement dated 19 October 2003) would then make a loan or would otherwise provide funding to Dragon.

Pursuant to this arrangement Arrowhead made the following loans to Metro, totalling US $28 million and UK £5 million, all with an interest rate of 22% per annum (which no doubt reflected the high risk to which Mr. Simmonite had referred in his e-mail dated 9 December 2003 and the fact that conventional bank financing was not likely to be available), although the loans were later re-scheduled at lower rates:

In February 2004 Dragon resumed trading, using the increased capital that was now available to it to enter into significantly larger transactions. At about the same time, however, HMCE advised Dragon on 4 February 2004 that it was investigating one of its transactions for December 2003. A week or so later HMCE extended these investigations to cover all the December 2003 transactions.

In response to this development Dragon instructed KPMG to investigate its supply chain. KPMG began this work, which was additional to the services described in its 17 September 2003 engagement letter, in March 2004.

Dragon sought also to reassure its investors. It may well be, although the evidence about it is not clear, that there was a meeting with Mr. Fry of Arrowhead in February 2004 at which KPMG was present. An e-mail from Mr. Robinson of Caydal dated 19 February 2004 refers to a visit by Mr. Fry to London at which such a meeting would be organised, with the comment that meeting KPMG would be "most important since they do diligence and supply chain checking for us". There is, however, no evidence about what transpired at any such meeting if it took place.

A meeting did take place on 8 March 2004 attended by KPMG (including Mr. Simmonite), Dragon and representatives of Caydal including Mr. Robinson, but this did not include anyone from Arrowhead. Mr. Simmonite is recorded by the meeting note as having informed the meeting that all KPMG client diligence checks on supplier chains had so far been successful, with clients having been investigated on six occasions where KPMG’s supplier chain checks had ensured repayment of the funds withheld.

On 22 March 2004 Dragon arranged a conference call with Mr. Alan Zenk of Arrowhead in which Mr. Simmonite would participate. The e-mail setting up this call read as follows:

“Steve -- As part of our continued efforts to make Dragon's main investor happy, we would like to coord. a call with you, me and their analyst Alan Zenk to discuss the VAT return scenario. We have explained our position and strategy focused on negating capital risk to the extent possible and minimizing time risk through proactive strategies (such as your checking supply chains proactively). I think Alan would just like to hear your perspective.”

The reference to minimising time risk arose from the fact that, once HMCE had decided to investigate transactions, its investigations could take considerable time. However, Dragon hoped that the supply chain investigations being carried out by KPMG (ie the investigation of past transactions) would be sufficient to satisfy HMCE as to the genuineness of the transactions in question so as to enable the VAT to be recovered.

The proposed call took place the following day. There is no evidence about it from any participant, but a manuscript note exists which appears to record Mr. Simmonite describing his experience having worked with KPMG for nine years and for HMCE for 18 years before that, referring to the work which KPMG was doing to check Dragon's supply chain for new transactions, explaining the procedure for challenging HMCE’s decisions to withhold repayment of VAT, and stating that KPMG had a 100% success rate on customs challenges for VAT reimbursement when its due diligence process had been followed.

On 2 April 2004 HMCE informed Dragon that all of the transactions covered by its February and March VAT returns were being investigated, and on 19 April 2004 Dragon ceased trading.

On various dates between July and November 2004 HMCE formally rejected all of Dragon's VAT claims for purchases covered by its returns for December 2003 and February to April 2004 on the basis that there was a "missing trader" in the supply chain and that the purchases and sales, judged objectively, were devoid of economic substance, not forming part of any economic activity.

Dragon was entitled to appeal to the VAT & Duties Tribunal against these decisions and duly did so, an earlier application for judicial review having been refused on the ground that this alternative remedy existed. However, on 4 November 2008 Dragon's appeals were dismissed by consent. This means that Dragon accepted that, objectively, it had in 2003 and 2004 the means of knowledge that by its purchases it was participating in transactions connected with the fraudulent evasion of VAT – or, in other words, that even though it did not in fact know that this was the case, it should have known and would have done so if it had made sufficient inquiries. Following this dismissal of the appeal, Dragon was ordered to be wound up on 18 March 2009 and on 30 March 2011 it was dissolved with no distribution to creditors.

Meanwhile, at some point during 2006, Arrowhead’s board of directors determined that the value of its loans to Metro needed to be written down in its accounts as a result of the fact that full recovery of the VAT by Dragon was doubtful. As a result, although the loans had a face value of over US $53 million including interest, they were recorded in Arrowhead's accounts for the year ending 31 December 2006 as having a value of only some US $9 million. PriceWaterhouseCoopers, Arrowhead’s auditors, certified these accounts, while noting the inherent uncertainty of valuing such investments for which no ready market existed.

In the event, although some payments were made by Dragon FZ to Metro, and by Metro to Arrowhead, Metro defaulted on its loan to Arrowhead when required to repay in February 2007. Arrowhead calculates that as at 1 December 2011 the outstanding principal amounted to US $30,180,370, with accrued interest of US $22,482,863, a total of US $52,663,233.

Arrowhead's claim against KPMG is in tort, as it is not suggested that there was any contractual relationship between the parties. It is Arrowhead's case that KPMG owed a duty of care not only to Dragon as its client, but also to Metro and to Arrowhead as (indirect) investors in Dragon. The way in which this duty is said to arise is as follows.

First, it is said that Mr. Simmonite, and through him KPMG, understood or should have understood:

There is no evidence that KPMG was aware of the precise relationship between Dragon, Metro and Arrowhead, or of the precise financing structure which was put in place, at any rate until after it was put in place. Subject to that, however, I accept these propositions for the purpose of this application. I proceed on the basis that KPMG understood fully the critical nature of the success of Dragon’s VAT repayment claims to the viability of its business, while Mr. Simmonite’s expertise consisted of his knowledge of what was required in order to satisfy HMCE that such claims should be allowed. It would therefore have been readily apparent to KPMG that the recoverability of VAT would be of great importance to any investor providing finance to Dragon, and that Dragon was unlikely to be able to offer any security other than its VAT repayment claims. KPMG knew that Dragon was seeking to raise finance to expand its trading substantially, and that loan finance was one of the options being considered. It knew also that Mr. Robinson of Caydal was involved in these efforts, and it had at least some contact with him. It knew also that conventional bank finance would be difficult or perhaps even impossible to obtain and (probably) that the pool of potential lenders was limited. It would have been at the very least a reasonable inference that the reason why Dragon introduced KPMG to an investor such as Caydal in September 2003 was in order to provide Caydal with reassurance as to the efficacy of its systems and procedures for ensuring the recoverability of VAT, and KPMG knew also that Dragon was drawing attention to KPMG's involvement in the documents which it was using in order to attract investors generally in December 2003, although it is not suggested that there was direct contact between KPMG and Arrowhead at this time.

Second, reliance is placed on the content of the conference call held on 23 March 2004, in which KPMG described the work which it was undertaking and the 100% success rate which it had achieved for other clients. Of course this call took place after six of the eight loans made by Arrowhead, with a total value of US $28 million, had already been made, and therefore cannot have had any causative effect on Arrowhead's decision to make those loans. However, Arrowhead contends that even if there is at present no evidence that similar conversations had taken place at an earlier stage before Arrowhead began to lend, what was said during the call held on 23 March 2004 is indicative of the kind of thing which is likely to have been said in earlier contacts. In my judgment, however, this speculation is highly unlikely to be well-founded. No documentary records to support it have been produced and there is no witness evidence from anyone who participated in, or was told about, any such conversation. There is, as I have said, no evidence of any direct contact between KPMG and Arrowhead in December 2003 or January 2004. Mr. Mark Whelan, Arrowhead's solicitor who has made a witness statement opposing this application on the basis of instructions from Mr. James Fry who was the principal of Arrowhead's investment manager, does not suggest that there was any such conversation. Whatever may have been said in any conversations with Caydal in September 2003, Arrowhead only arrived on the scene as a potential investor in December 2003.

In my judgment, therefore, the evidence about the 23 March 2004 telephone call does not add materially to the essential point that KPMG was aware that potential investors were being told by Dragon about its involvement and would be likely to rely on this as providing reassurance that Dragon's VAT repayment claims would be successful. Nor is there any reasonable prospect that it would do so after a trial.

The way in which Arrowhead has pleaded its case for the imposition of a duty of care, contained in paragraph 58 of the Particulars of Claim, is as follows:

“As a result of KPMG knowing the purpose to which [Dragon] intended to use [KPMG's services], in particular that [Dragon] would relay to investors such as Arrowhead and Metro the advice and assurances which KPMG gave [Dragon], KPMG also owed each of Arrowhead and Metro a duty to take reasonable care when providing the services.”

Essentially, therefore, the foundation for Arrowhead's case for the imposition of a duty of care is the fact that, as it is said, KPMG knew that Dragon would relay to investors the assurances which KPMG had given to Dragon. It is not suggested, however, that these “assurances" consisted of anything approaching a warranty that particular repayment claims would be successful. Rather, the assurance was that proper systems were in place. As Mr. Whelan, Arrowhead’s solicitor, put it in his witness statement:

“It was the Services that KPMG provided pursuant to its letter of engagement that animated the funding arrangements without which [Dragon] could not have carried out its business. KPMG knew that the Services were relied upon by [Arrowhead] to give it the necessary assurance that Dragon's business was not connected to fraudulent traders and that Dragon had in place procedures, systems and documentation that were sufficiently robust to meet a HMCE investigation of the sort which had been foreshadowed in the Budget. The ‘threat’ as KPMG termed it. This ‘fraud prevention’ function supplied the security that the investors in [Dragon's] business model demanded. Without that security, there was no other sufficient security for the loans. This is because [Dragon's] working capital and profit were tied up in its VAT returns. This was self-evident from [Dragon's] business model and would have been apparent to KPMG who were specialists in this area."

It is then said that in breach of its duty to both Arrowhead and Metro, KPMG performed its services negligently and failed to uncover the fraud within Dragon's supply chains or to provide Dragon (or Arrowhead or Metro as investors in Dragon) with warnings as to the hallmarks of fraudulent trading; and that it failed to carry out sufficiently stringent checks on Dragon's proposed counterparties so as to meet HMCE’s requirements for a VAT refund.

KPMG challenges vigorously these allegations of negligence. However, for the purpose of this application they must be assumed to be correct. The consequence of this assumption is important. If the way in which Arrowhead puts its case is correct, it means that Dragon's repayment claims were always going to fail, at any rate if they were investigated by HMCE. That is because it must be assumed that there was indeed fraud in the supply chain; that such fraud could have been discovered if reasonable steps had been taken and would therefore come to light on any HMCE investigation; and that Dragon would be unable to satisfy HMCE that despite the existence of such fraud, it had nevertheless taken appropriate steps to guard against it. Indeed, Dragon eventually accepted all these facts, at any rate by necessary implication, by consenting to the dismissal of its appeal to the VAT & Duties Tribunal.

Arrowhead says that this breach of duty by KPMG caused it to suffer damage because it relied on KPMG's proper performance of its services in advancing funds to Metro by way of loans and would not otherwise have made any of the loans. It draws no distinction in this respect between the position before and after the telephone call of 23 March 2004 referred to in [25] above. The damage claimed is the amount outstanding on the loan to Metro.

The circumstances in which a duty of care will be found to exist have been considered in many cases at the highest level. The various approaches were described by Lord Mance in Customs & Excise Commissioners v. Barclays Bank Plc [2006] UKHL 28, [2007] 1 AC 181 at [82]:

“The conceptual basis on which courts decide whether a duty of care exists in particular circumstances has been repeatedly examined. Three broad approaches have been suggested, involving consideration (a) whether there has been an assumption of responsibility, (b) whether a threefold test of foreseeability, proximity and ‘fairness, justice and reasonableness’ has been satisfied or (c) whether the alleged duty would be ‘incremental’ to previous cases.”

Lord Mance added at [84] that all three approaches would often lead to the same result, although this was not necessarily so. All of their Lordships emphasised the importance (in Lord Bingham’s words at [18]) of the need to “concentrate attention on the detailed circumstances of the particular case and the particular relationship between the parties in the context of their legal and factual situation as a whole.”

In the present case Arrowhead contends that a duty of care should be imposed on the basis of both an assumption of responsibility and the threefold test. I consider each in turn.

The assumption of responsibility test was described by Lord Bingham in Customs & Excise Commissioners v. Barclays Bank Plc at [4] as being:

“whether the defendant assumed responsibility for what he said and did vis-à-vis the claimant, or is to be treated by the law as having done so.”

Lord Bingham added that the paradigm situation of an assumption of responsibility is “a relationship having all the indicia of contract save consideration" and, at [5], that the test “is to be applied objectively and is not answered by consideration of what the defendant thought or intended”.

Lord Hoffmann said, at [35]:

“There is a tendency, which has been remarked upon by many judges, for phrases like ‘proximate’, ‘fair, just and reasonable’ and ‘assumption of responsibility’ to be used as slogans rather than practical guides to whether a duty should exist or not. These phrases are often illuminating but discrimination is needed to identify the factual situations in which they provide useful guidance. For example, in a case in which A provides information to C which he knows will be relied upon by D, it is useful to ask whether A assumed responsibility to D: Hedley Byrne & Co Ltd v. Heller & Partners Ltd [1964] AC 465; Smith v. Eric S Bush [1990] 1 AC 831. Likewise, in a case in which A provides information on behalf of B to C for the purpose of being relied upon by C, it is useful to ask whether A assumed responsibility to C for the information or was only discharging his duty to B: Williams v. Natural Life Health Foods Ltd [1998] AC 830. Or in a case in which A provided information to B for the purpose of enabling him to make one kind of decision, it may be useful to ask whether he assumed responsibility for its use for a different kind of decision: Caparo Industries plc v. Dickman [1990] 2 AC 605. In these cases in which the loss has been caused by the claimant's reliance on information provided by the defendant, it is critical to decide whether the defendant (rather than someone else) assumed responsibility for the accuracy of the information to the claimant (rather than to someone else) or for its use by the claimant for one purpose (rather than another). The answer does not depend upon what the defendant intended but, as in the case of contractual liability, upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case.”

In Williams v. Natural Life Foods Ltd [1998] 1 WLR 830 Lord Steyn stated at 835:

“The touchstone of liability is not the state of mind of the defendant. An objective test means that the primary focus must be on things said or done by the defendant or on his behalf in dealings with the plaintiff. Obviously, the impact of what a defendant says or does must be judged in the light of the relevant contextual scene. Subject to this qualification, the primary focus must be on exchanges (in which term I include statements and conduct) which cross the line between the defendant and the plaintiff.”

As already indicated, I accept, at any rate for the purpose of this application, that KPMG knew that it had been engaged by Dragon because of its expertise in dealing with VAT repayment claims, that the success of these claims was fundamental to Dragon’s business, that it was an essential part of Dragon’s business plan that it would seek to expand the scale of its trading operations for which it needed to attract investors, that there was a limited pool of potential investors, that as part of its marketing in seeking to attract such investors Dragon was telling them that KPMG’s involvement ensured (in Mr. Whelan’s words quoted at [37] above) “that Dragon had in place procedures, systems and documentation that were sufficiently robust to meet a HMCE investigation of the sort which had been foreshadowed in the Budget”, and that this would be of vital importance to investors. Nor did KPMG ever protest that Dragon should not mention its involvement in its negotiations with prospective investors. However, at any rate until the telephone call of 23 March 2004 which came too late to have been causative in Arrowhead’s decision to make the loans (see [23] to [25] and [34] above), or possibly a meeting in February 2004 if there was one (see [21]), there was no direct communication (nothing which “crossed the line”) between KPMG and Arrowhead.

Undoubtedly KPMG assumed responsibility to Dragon for the proper performance of its services. It did so on the terms of the contract set out in its engagement letter and in its terms and conditions. These included specific limitations on the extent of the responsibility which it was prepared to assume including a cap on its financial liability. It has not been suggested that this cap would not have been effective to limit KPMG’s liability towards Dragon, and in my judgment there is no reason to suppose that it would not have been. Although Arrowhead would not have known the precise terms on which KPMG had been engaged by Dragon, Mr. Coppel accepted that any reasonable businessman would have expected that there would be a written engagement of KPMG which would be likely to contain such terms.

In such circumstances it is inconceivable, in my judgment, that any reasonable businessman would have considered that KPMG was voluntarily assuming an unlimited responsibility towards potential investors in Dragon. This would apply to direct investors, but applies with even greater force to an investor such as Arrowhead which was investing at several removes. If the question had been raised in some notional conversation between Arrowhead and KPMG, it is obvious that KPMG would not have been prepared to accept such an unlimited responsibility. This is underlined by Mr. Simmonite’s reference in his e-mail dated 9 December 2003 (see [14] above) to the “high risk nature of the business”, as a result of which it would be unusual for a bank to be willing to treat VAT repayments as an asset for the purpose of lending. While this was not a communication to Arrowhead, the information which it contains must have been obvious to Arrowhead whose role was to provide finance which was not obtainable from more readily available sources, and is therefore part of the relevant background against which the parties' conduct is to be assessed. Similarly, while Arrowhead probably did not know of the particular express exclusion in KPMG’s general terms of business of any third party rights, this was not an unusual term and was the sort of term which a reasonable businessman would expect to find there.

Although KPMG knew that its involvement was being described to potential investors by Dragon, there is objectively no reason to suppose that it was prepared to accept any responsibility other than its responsibility to Dragon in accordance with the terms of its engagement letter, let alone responsibility to a whole chain of investors such as was put in place in this case. KPMG in my judgment did not assume responsibility to Arrowhead, but (in Lord Hoffmann’s terms) was only discharging its duty to Dragon. Far from the relationship between Arrowhead and KPMG having all the indicia of contract save for consideration, there was no direct contact between them until a relatively late stage and one of the obvious and important indicia of a contractual relationship in such a context, namely an engagement letter defining KPMG’s services and the extent of its liability, was missing.

Accordingly, to hold that there was a voluntary assumption of responsibility by KPMG towards Arrowhead would fly in the face of the reasonable expectations of businessmen. The only reasonable inference from the parties' conduct against the background of all the circumstances of the case is that no such responsibility was assumed.

Turning to the threefold test, this was described by Lord Bingham in Customs & Excise Commissioners v. Barclays Bank Plc at [4] as follows:

“whether loss to the claimant was a reasonably foreseeable consequence of what the defendant did or failed to do; whether the relationship between the parties was one of sufficient proximity; and whether in all the circumstances it is fair, just and reasonable to impose a duty of care on the defendant towards the claimant.”

Mr. Coppel relied in particular on two cases, Smith v. Eric S Bush [1990] 1 AC 831 and Caparo Industries v. Dickman [1990] 2 AC 605. In Smith v. Bush a building society instructed the defendant surveyors to report on the value of a house to be purchased by the claimant, who paid for and received a copy of the report, on which she relied without obtaining any further survey herself. The House of Lords held that a valuer instructed by a prospective mortgagee to carry out a valuation of a modest house for the purpose of deciding whether to grant a mortgage owed a duty of care to the mortgagor to exercise reasonable skill and care if he was aware that the mortgagor would probably purchase the house in reliance on the valuation without an independent survey, at any rate unless the valuer had made a disclaimer of liability to the mortgagor which satisfied the requirements of the Unfair Contract Terms Act 1977. As this brief summary shows, however, the context for this decision is far removed from the present case.

Caparo Industries v. Dickman [1990] 2 AC 605 was the case in which the threefold test was first stated, by Lord Bridge at 617H. It was a claim by both existing and potential investors alleging negligence by the defendant auditors in their certification of a company's annual accounts as showing a true and fair view of the company's financial position. The House of Lords held that the purpose of the statutory requirement for an audit of public companies was the making of a report to enable shareholders to exercise their rights in general meeting and did not extend to the provision of information to assist existing or potential shareholders in the making of investment decisions, so that no relevant duty of care was owed. This was despite the fact that (on the assumed facts) the auditors should have known that any potential investor in the company would rely on the accuracy of the company's accounts.

After referring to some cases (including Smith v. Bush) in which a duty of care was held to exist, subject to the effect of any disclaimer, Lord Bridge observed at 630H:

“The salient feature of all these cases is that the defendant giving advice or information was fully aware of the nature of the transaction which the plaintiff had in contemplation, knew that the advice or information would be communicated to him directly or indirectly and knew that it was very likely that the plaintiff would rely on the advice or information in deciding whether or not to engage in the transaction in contemplation. In these circumstances the defendant could clearly be expected, subject always to the effect of any disclaimer of responsibility, specifically to anticipate that the plaintiff would rely on the advice or information given by the defendant for the very purpose for which he did in the event rely on it. So also the plaintiff, subject again to the effect of any disclaimer, would in that situation reasonably suppose that he was entitled to rely on the advice or information communicated to him for the very purpose for which he required it.”

However, the decision of the House of Lords demonstrates that such knowledge on the part of the defendant is not necessarily sufficient for a duty to be imposed. The defendant auditors were assumed to have had such knowledge, but nevertheless owed no duty of care to investors or potential investors.

I would accept that in some contexts the defendant’s knowledge of and consent to the fact that his advice is being passed on by his client to a third party, who will rely on it for the purpose of making an investment (using that word in a broad sense), may be sufficient to enable the third party to demonstrate sufficient foreseeability and proximity, and that the context may also show that it is fair, just and reasonable in such circumstances to impose a duty of care owed by the defendant to the third party. That is generally more likely to be the case when the third party claimant is a consumer and the context is an ordinary transaction such as the purchase of a house (as in Smith v. Bush) than in a carefully structured business context such as the present case, where the claimant was a sophisticated investor dealing with the known risk of not recovering VAT repayments as a result of the “HMCE threat”. As the cases make clear, in determining what is fair, just and reasonable, context is all important.

I would be prepared to assume for present purposes that Arrowhead is able to satisfy the requirements of foreseeability and (though with some hesitation) proximity. Even so, however, in my judgment it would not be fair, just and reasonable to impose a duty of care on KPMG. This is for essentially the same reason that I have concluded that the case based on assumption of responsibility must fail. That is to say, it would not be fair, just and reasonable to impose a duty of care on KPMG which could result in unlimited liability (or at any rate, liability up to the full amount of the loans to be advanced by Arrowhead, together with a high rate of interest on such loans) when it would have been obvious to all concerned, first that KPMG’s relationship with its client, Dragon, was governed by an engagement letter which was likely to contain limitations on the extent of KPMG’s liability and very possibly an exclusion of liability to third parties, second that the business in which Dragon proposed to engage was a high risk business, and third that KPMG would not have been prepared to accept such a responsibility to Arrowhead if it had been asked to do so.

In my judgment, therefore, whether put in terms of assumption of responsibility or the threefold test, KPMG owed Arrowhead no duty of care. While the question whether such a duty existed will always depend on the particular facts of the case, there are in my judgment no facts not presently known which could reasonably be expected to emerge in the course of the trial process which would affect the decisive considerations which I have identified. Accordingly KPMG is entitled to summary judgment on this ground.

Section 2 of the Limitation Act 1980 provides that:

“An action founded on tort shall not be brought after the expiration of six years from the date on which the cause of action accrued.”

In some circumstances this six year period can be extended under section 14A of the Act, but it is not suggested that these circumstances apply here.

A cause of action in negligence accrues when the claimant sustains damage.

In the present case Arrowhead contends that it only sustained damage on one or other of two events, each of which was after 30 August 2005 and therefore within the limitation period. These were (a) 4 November 2008, when Dragon’s appeal to the VAT & Duties Tribunal was dismissed by consent, and (b) at the earliest, some time during 2006 when the board of Arrowhead decided that the value of its loans needed to be written down in its accounts. Prior to these events, Arrowhead maintains that it had suffered no more than a contingent loss, which does not constitute actual damage. There was also reference in Arrowhead’s Particulars of Claim and in its evidence to the date of 30 March 2011, when Dragon was dissolved with no distribution to creditors, at which time it was said that Arrowhead’s loss became certain. However, I did not understand Mr. Coppel to submit that no damage was suffered until this date and he was right not to do so.

In contrast, KPMG’s case (on the disputed assumption that its negligent conduct caused Dragon’s repayment claims to fail) is that the damage was sustained immediately upon Arrowhead making its loans to Metro.

Many cases have considered what is meant by the sustaining of damage in the context of a claim for financial loss. For present purposes the most relevant case is Nykredit Mortgage Bank Plc v. Edward Erdman Group Ltd [1997] 1 WLR 1627, which was concerned with damage suffered by the claimant as a result of making a loan which would not have been made but for the defendant's negligence in valuing a property which was to be the security for the loan. The borrower defaulted at once and the claimant lender sued the negligent valuer. The question for the House of Lords was the date from which interest on damages should be awarded, which depended on the date when the claimant's cause of action arose. The claimant contended that this occurred immediately upon the making of the loan, while the defendant valuer contended that the cause of action only arose when the property was sold, which was when the claimant was visited with the consequence of the valuation being wrong.

Lord Nicholls held that "damage" in the context of claims for purely financial loss meant "actual damage" or, as he also put it, "measurable, relevant loss". But when does this occur? Lord Nicholls gave the example at 1631C of a lender who would not have made the loan if he had been properly advised, pointing out that in one sense he suffered detriment immediately the transaction was completed because he had parted with his money when he would not have done so if he had been properly advised; but that in another sense he might suffer no loss at all because there was no certainty that the borrower would default, and even if there was a default the security might still be sufficient. Financial loss was possible but, depending on the facts, not certain, and perhaps not even likely. In such a case, it was necessary to compare the claimant's position if he had not entered into the transaction and his position as it actually was:

“When this is so, a professional negligence claim calls for a comparison between the plaintiff's position had he not entered into the transaction in question and his position under the transaction. That is the basic comparison. Thus, typically in the case of a negative valuation of an intended loan security, the basic comparison called for is between (a) the amount of money lent by the plaintiff, which he would still have had in the absence of the loan transaction, plus interest at a proper rate, and (b) the value of the rights acquired, namely the borrower's covenant and the true value of the overvalued property.”

Having made the point that it may be necessary to bring into account the fact that a defendant such as a negligent valuer is not necessarily liable for all the consequences which flow from the lender having entered into the transaction but only for those which are attributable to the deficiency in the valuation, a factor which does not arise in the present case, Lord Nicholls returned to the question of valuing the rights acquired by the lender at 1632B-F and 1633B:

“The basic comparison gives rise to issues of fact. The moment at which the comparison first reveals a loss will depend on the facts of each case. Such difficulties as there may be are evidential and practical difficulties, not difficulties in principle.

Ascribing a value to the borrower's covenant should not be unduly troublesome. A comparable exercise regarding lessees' covenants is a routine matter when valuing property. Sometimes the comparison will reveal a loss from the inception of the loan transaction. The borrower may be a company with no other assets, its sole business may comprise redeveloping and reselling the property, and for repayment the lender may be looking solely to his security. In such a case, if the property is worth less than the amount of the loan, relevant and measurable loss will be sustained at once. In other cases the borrower's covenant may have value, and until there is default the lender may presently sustain no loss even though the security is worth less than the amount of the loan. Conversely, in some cases there may be no loss even when the borrower defaults. A borrower may default after a while but when he does so, despite the overvaluation, the security may still be adequate.

It should be acknowledged at once that, to greater or lesser extent, quantification of the lender's loss is bound to be less certain, and therefore less satisfactory, if the quantification exercise is carried out before, rather than after, the security is ultimately sold. This consideration weighed heavily with the High Court of Australia in Wardley Australia Ltd. v. Western Australia (1992) 175 C.L.R. 514. But the difficulties of assessment at the earlier stage do not seem to me to lead to the conclusion that at the earlier stage the lender has suffered no measurable loss and has no cause of action, and that it is only when the assessment becomes more straightforward or final that loss first arises and with it the cause of action. ...

... As Mr. Briggs Q.C. submitted, no accountant or prospective buyer, viewing the loan book of a commercial lender, would say that the shortfall in security against outstanding loans to defaulting borrowers did not represent a loss to the lender merely because the securities had yet to be sold. Realisation of the security does not create the lender's loss, nor does it convert a potential loss into an actual loss. Rather, it crystallises the amount of a present loss, which hitherto had been open to be aggravated or diminished by movements in the property market.”

The approach of Lord Hoffmann, who gave the only other reasoned speech, was the same. He referred to the need for a claimant to show that it was “worse off” (explained in subsequent cases as meaning “financially worse off”) as a result of the defendant’s over valuation of the security, and continued at 1639B:

“There may be cases in which it is possible to demonstrate that such a loss is suffered immediately upon the loan being made. The lender may be able to show that the rights which he has acquired as lender are worth less in the open market than they would have been if the security had not been overvalued. But I think that this would be difficult to prove in a case in which the lender’s [sc. borrower’s] personal covenant still appears good and interest payments are being duly made. On the other hand, loss will easily be demonstrable if the borrower has defaulted, so that the lender’s recovery has become dependent upon the realisation of his security and that security is inadequate.”

Actual damage is to be contrasted with damage which is no more than contingent. It was so held in Law Society v. Sephton & Co [2006] UKHL 22, [2006] 2 AC 543, a case where as a result of negligence by the defendant accountant in certifying a dishonest solicitor's accounts, the Law Society was exposed to the possibility of claims for compensation by the solicitor’s former clients. However, that did not necessarily mean that such claims would in fact be made. The House of Lords held that the damage required to complete the Law Society’s cause of action only occurred when a former client actually made a claim. It was not sufficient that the Law Society was exposed to a claim or even that a claim was likely.

Commenting on Nykredit, Lord Hoffmann observed at [20]:

“Nykredit therefore decides that in a transaction in which there are benefits (covenant for repayment and security) as well as burdens (payment of the loan) and the measure of damages is the extent to which the lender is worse off than he would have been if he had not entered into the transaction, the lender suffers loss and damage only when it is possible to say that he is on balance worse off. It does not discuss the question of a purely contingent liability.”

Lord Hoffmann concluded at [30]:

“In my opinion, therefore, the question must be decided on principle. A contingent liability is not as such damage until the contingency occurs. The existence of a contingent liability may depress the value of other property, as in Forster v. Outred & Co [1982] 1 WLR 86, or it may mean that a party to a bilateral transaction has received less than he should have done, or is worse off than if he had not entered into the transaction (according to which is the appropriate measure of damages in the circumstances). But, standing alone as in this case, the contingency is not damage.”

The reasoning of the other members of the House was to similar effect.

Subsequently in Axa Insurance Ltd v. Akther & Darby [2009] EWCA Civ 1662, [2010] 1 WLR 1662 the Court of Appeal had to apply these principles to a case where solicitors had been negligent in vetting personal injury claims to determine whether they should be accepted into an after-the-event legal expenses insurance scheme. It was held that damage was suffered, and the cause of action accrued, when the claims were accepted into the scheme (or when the solicitors failed to advise that claims already accepted should no longer be covered) and not merely when a claim could have been made under the policy (typically, when an order for costs was made against the policyholder). This was because the claimant insurer incurred a liability to policyholders which was immediately more burdensome, and the package of rights it acquired was less valuable, than should have been the case if the vetting breaches had not occurred (see in particular Arden LJ at [62] and Longmore LJ at [82]).

From these cases I derive the following principles applicable to the present case, which is (or must be assumed to be) a case in which Arrowhead would not have made the loans to Metro but for KPMG's negligence.

First, there must be actual measurable damage, although this does not necessarily mean that the damage is capable of final quantification. The mere possibility of damage is not enough.

Second, the mere fact that a lender enters into a transaction by making a loan which it would not otherwise have made may, but does not necessarily, amount to damage.

Third, whether the making of the loan does constitute damage depends upon a comparison (what Lord Nicholls described as “the basic comparison”) between the amount of the loan and the value of the rights which the lender acquires.

Fourth, those rights will generally consist, as they do in this case, of (i) the borrower’s (in this case, Metro’s) covenant to repay and (ii) the true value of the security (in this case, Dragon’s VAT repayment claims).

Fifth, these are all issues of fact which depend upon the evidence. Accordingly, on an application for summary judgment, it is necessary to consider whether the material before the court is sufficient to enable the comparison to be made with a sufficient degree of certainty for the purpose of such an application.

I turn, therefore, to consider the value of Metro’s covenant to repay the loan. Arrowhead accepts, indeed contends, that the effect of KPMG's negligence was that its loans to Metro were made in circumstances which were more hazardous than Arrowhead had been given to believe, but it says that those circumstances did not reduce Metro’s obligation to repay the loans or affect its initial compliance with its obligation. It says that Metro’s initial compliance with its repayment obligations demonstrates that damage in the sense of measurable loss had not yet occurred. In Nykredit the fact that the borrower’s covenant was worthless was demonstrated by the fact that it defaulted at once. However, as the passage quoted at [69] above from Lord Hoffmann’s speech in Nykredit makes clear, the fact that for the time being loan repayments are being duly made is not necessarily a reason for concluding that no measurable damage has yet been suffered. Rather, this is a matter which depends on the facts as a whole. If loan repayments are being made, that may make it difficult to prove that the borrower’s covenant has no value, but this remains a question of fact. A borrower who takes out a substantial loan may have some modest savings which will enable him to make some initial repayments. But if that is all he has, and if the security provided is worthless, it cannot be said that the lender has not yet suffered any loss.

In the present case it is clear that there was never any possibility that Metro’s covenant would be sufficient to repay the loans made by Arrowhead, even if Metro was able to and did make some initial repayments, whether of interest or capital. On the contrary it is clear that Metro’s ability to repay the loans in full was entirely dependent on the security of Dragon’s VAT repayment claims. The availability of these claims was fundamental to the whole arrangement. Any accountant valuing the loans in Arrowhead’s books without the security of the VAT repayment claims would have concluded that the loans would need to be substantially written down if their repayment was dependent upon the value of Metro’s covenant. Indeed that is precisely what Arrowhead’s board of directors and PriceWaterhouseCoopers, Arrowhead’s auditors, did conclude once it became apparent to them that full recovery of the VAT repayment claims was doubtful. In my judgment there is no realistic prospect that any different conclusion on this point would be reached after a trial.

The next question is what (if any) value can be attributed to the VAT repayment claims. KPMG contends that (despite Dragon’s misplaced confidence, at any rate until some time in 2006, that its appeal would succeed) these never had any value as the factors which caused them to be rejected and which resulted in the dismissal of Dragon's appeal were objective factors which existed from the outset. Indeed the claims could only be rejected if that was so (see [39] above). Arrowhead, however, contends that Dragon was entitled to the VAT repayments, subject to various contingencies that its claim would fail, and that damage only occurred in November 2008 when its appeal was finally dismissed.

Mr. Coppel identified three such contingencies without which, he said, it could not be said whether Arrowhead had suffered actual damage. The first was that HMCE might not investigate the repayment claims, as it would not have the resources to investigate every claim for VAT repayment. If there was no investigation, the claim would succeed. The second was that, even if HMCE did investigate, the result of the investigation would not necessarily be a rejection of the claims. The third was that, even if HMCE rejected the claim, an appeal to the VAT & Duties Tribunal might succeed.

Looking at the matter objectively, Dragon’s VAT repayment claims were always going to fail. It has to be assumed for the purpose of this application that there was in fact a fraud at some point in the supply chain, which appropriate checks would have detected. Therefore Dragon should have known, having regard to objective factors, that it was participating in a transaction connected with fraudulent evasion of VAT. However, the result of KPMG’s (assumed) negligence was that appropriate checks were not carried out and the fraud was not detected, either because KPMG failed to carry them out itself or because it failed to provide Dragon with a proper system for carrying out such checks. Dragon was therefore unable at all material times to satisfy HMCE that it had taken appropriate steps to guard against the possibility of fraud in the supply chain, and would be unable to meet the requirements for recovery of VAT in the event of a challenge.

Even if there was initially a possibility that no investigation into the repayments would be made, and that HMCE might simply refund the VAT without inquiry, a possibility which seems highly unlikely in view of the very substantial amounts involved, all the claims had in fact been rejected by HMCE by November 2004. From then on, although Dragon had a right of appeal to the VAT & Duties Tribunal, as a matter of objective fact its appeal had no real prospect of success, even if this was not appreciated at the time. The only prospect which might be said to have existed is that HMCE would conduct the proceedings incompetently or that the Tribunal might reach a perverse decision. But that sort of remote possibility does not mean that the damage was merely contingent. It is always possible that the effect of a defendant’s negligence may go unnoticed. For example, a purchaser who buys a house with a defective title as a result of his solicitor’s negligence may be lucky when he comes to sell the house because his own purchaser’s solicitor fails to spot the defect. But that does not mean that he has not suffered actual measurable damage.

Eventually Arrowhead’s appeal was dismissed by consent, but Mr. Coppel did not suggest that there was any new development or material change of circumstances between November 2004 and the dismissal of the appeal in November 2008 which caused this to happen or which turned a good case into one which it was accepted had to fail. He disclaimed any reliance in this regard on the European Court of Justice decisions in 2006, as Arrowhead’s case was that KPMG’s negligence was already insufficient to meet the requirements of HMCE as they were in 2003 and 2004. Indeed this has to be Arrowhead’s case, as if KPMG’s work was sufficient to comply with whatever standards existed in 2003 and 2004, any allegation of negligence would crumble away.

The submission that damage was not suffered until the dismissal of the appeal in November 2008 is further contradicted by the fact of Arrowhead’s decision in 2006 to write down the value of the loans. This demonstrates that by this time the damage was not only measurable, but had in fact been measured by Arrowhead in a very substantial sum, even if the estimate was inherently uncertain, as the auditors commented (see [29] above). What was uncertain was the quantification of the estimate, but not the fact of damage. It may be that (as Arrowhead suggests) this decision was prompted by the European Court cases, but (once any case that these cases made a material change to Dragon’s right to repayment is disclaimed), this did no more than reflect the position as it had in fact existed since at least November 2004. The fact that Arrowhead (or, for that matter, Dragon) may only have realised in 2006 that Dragon’s claims were likely to fail makes no difference. Whether actual measurable damage has been sustained is an objective and not a subjective matter.

I conclude, therefore, that even if Arrowhead had not already sustained actual damage at the date of making the loans, which it probably had but which I need not decide, it had done so at the latest by November 2004, which is more than six years before the commencement of this action.

Once again, there is in my judgment no realistic prospect that a trial would lead to any different conclusion.

It follows that the claim is time barred.

For the reasons which I have given, KPMG owed Arrowhead no duty of care and, even if it did, Arrowhead’s claim is time barred. KPMG is therefore entitled to summary judgment dismissing Arrowhead’s claim.